US: Puerto Rico: Failure of the State

The Puerto Rican economy has come a long way since it started to industrialize and modernize in the mid-1900s through what was called “Operation Bootstrap” in English, or “Operación Manos a la Obra” in Spanish. The process of industrialization was, by many measures, a success, even though some economic indicators have continued to point to many economic disequilibria that have persisted over time, such as a persistently high rate of unemployment as well as a high rate of inflation compared to the U.S. mainland, even though Puerto Rico uses the U.S. dollar as its currency and monetary policy is conducted by the U.S. Federal Reserve.

Authorities on the island have not been able to integrate the whole of the economy, as a large percentage of economic activity still happens underground in the informal sector. Several authors have written about this and have concluded that too much regulation, at the business permitting levels, labor regulations and the application of the U.S. minimum-wage law have kept the rate of unemployment high. Furthermore, many high-income individuals feel that they should not have to pay taxes or that they pay a disproportionate amount of taxes. This is not uncommon of an economy that has a large underground or informal economy, as governments tend to increase the tax burden on the “legal” or “formal” sectors of the economy because it is almost impossible to broaden the tax base and collect taxes from a larger number of individuals.

By some estimates, the Puerto Rican underground economy is as large as 30 percent of all economic activity on the island. 1 The inability to eliminate this underground economy has had serious consequences for the economy at all levels and for the island’s government, with its inability to collect taxes due to the limited tax base from “legal” tax payers. At a conference on the island at the end of the 1990s, an economist indicated that only about 10,000 Puerto Ricans say they earn more than $100,000 per year, according to data from the “Departamento de Hacienda,” the Puerto Rican Treasury Department, out of a population of almost 4 million, according to the U.S. Census Bureau. The comment was probably an exaggeration, but was not that farfetched. The truth is that, by the year 2000, a little more than 14,000 Puerto Ricans claimed to earn more than $100,000 according to official numbers released by the Puerto Rican Treasury Department. By 2009, the last official number available, that number had risen to 25,257 individuals/filers. This is an important increase in “wealthy” taxpayers and could be showing advances made in tax compliance during the last decade.

However, just by looking at Puerto Rico’s property prices (even after the severe housing downturn), the number of cars sold per year and the price of those cars (which is approximately 10 percent higher for “popular” cars and 30 percent to 40 percent higher for “luxury” cars than in the U.S. mainland), plus the number of luxury cars and yachts on the island’s piers, it is very difficult to believe that even these higher figures of individuals who earn more than $100,000 are correct. 2 Thus, while advances have been made, the road to make the Puerto Rican tax system inclusive and reduce the size of the underground economy has not ended.

Facing serious issues on its fiscal accounts and potentially more credit risk downgrades by the major rating agencies, the government of Puerto Rico embarked on a tax reform in 2010 that is still struggling to give the results it pursued. Some of the proposals included a reduction in tax rates, a change in tax scales, a “temporary” tax on multinational corporations, a reduction in tax credits and incentives and added measures to catch tax evaders. According to the government, the tax reform should “save” $1.2 billion from taxpayers’ pockets during the period of 2010-2016. However, little of those objectives have been met as reflected by labor and consumer market indicators.

In an effort to increase tax collections and refinance some “under the line” debt, the government of Puerto Rico implemented, in 2006, a consumption tax called IVU (Impuesto a la Venta y Uso, or Sales and Use Tax). The current tax rate for this consumption tax is 7 percent, 5.5 percent collected by the island government and 1.5 percent by the island municipalities. This tax has partially substituted an import tax called “arbitrios,” on which the government relied heavily. The government has not eliminated “arbitrios” completely, but now does not rely on the tax as much as it did in the past. The new IVU consumption tax started in November 2006 and part of the collection is a dedicated sales tax to pay for the “non-constitutional” debt incurred by the Puerto Rican government, or debt that was above and beyond what the island’s constitution allowed.

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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks.
If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets.
Higher Margin Maintenance Requirements on Volatile Issues
The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement.
Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account.
Fast Markets
A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system.
In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors.
Potential Risks in a Fast Market
"Real-time" Price Quotes May Not be Accurate
Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive.
Your Execution Price and Orders Ahead
In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading.
Initial Public Offerings may be Volatile
IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price.
Large Orders in Fast Markets
Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5.
In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees.
This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted.
Online Trading and Duplicate Orders
Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed.
Limit Orders Can Limit Risk
A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected.
Telephone and Online Access During Volatile Markets
During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent.
Freeriding is Prohibited
Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security.
Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days.
Stop and Stop Limit Orders
A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price.
A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price.
A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better.
Glossary
All or None (AON)
A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed.
Day Order
A buy or sell order that automatically expires if it is not executed during that trading session.
Fill or Kill
An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled.
Good Til Canceled (GTC)
An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order).
Immediate or Cancel
An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled.
Limit Order
An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases).
Maintenance Call
A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity.
Margin Requirement
Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales.
Market Makers
NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds.
Market Order
An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace.
Specialists
Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy.
Stop
An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price.
Stop Limit
An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order.
These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.

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